The author is a Forbes contributor. The opinions expressed are those of the writer.

Loading ...

Loading ...

This story appears in the {{article.article.magazine.pretty_date}} issue of {{article.article.magazine.pubName}}. Subscribe

The political landscape in India is shaping up to be promising. Indians go to the polls next month to elect a new batch of political leaders. Because this is the world's largest democracy, the voting process will take about a month to conclude. Investors are already pricing in positive outcomes to their favorite word: "reforms". They think they've got them already, and that's made India one of the best performing emerging markets around and the best of the BRICs.

Are investors getting too excited about an India led by Bharatiya Janata Party strongman Narendra Modi? His Bollywood handsomeness and promises to tackle corruption have helped push the Wisdom Tree India (EPI) exchange traded fund up 2.24% year-to-date. That's better than the MSCI Emerging Markets Index, better than the S&P 500 and better than the MSCI Europe.

BJP's Narendra Modi at the World Economic Forum in India. The 63 year old is seen replacing 81 year old Manmohan Singh as Prime Minister, who has been the leader of the Indian government since May 2004. (Photo credit: Wikipedia)

Usually, when markets like the way an election is turning out in an emerging market, stocks rise. Emerging market countries like India are more sensitive to elections than developed markets. On average, stocks in emerging outperform their benchmark by 3.5% one month before elections begin. This has been the case since 2000, according to research by Morgan Stanley. With one month to go before Indians go to the polls, the Dow Jones India Total Stock Market Index is up 1.05% while the MSCI Emerging Markets Index is down 6.74%.

After the election, if the turnout is as the market hoped, then emerging stocks tend to beat the benchmark by at least 0.7%.

India is so far ahead of the game, it's like Modi is already in power and the economic reforms both corporate and portfolio investors have been hoping for have already been put in place.

For one, many believe there will be continued changes to economic policy allowing for foreign direct investment in various sectors of the economy.

India recently opened up its airline industry to foreigners, with United Arab Emirates carrier Etihad Airways taking a controlling stake in Jet Airways. Foreigners were also allowed to invest in big box retail. That would have helped companies like Walmart move out of the wholesale market and into the retail market. So far, this reform has not gone according to plan, with lots of political infighting and lobbying by small business owners fearing Walmart will shut them down.

Local corporations also aren't expected to open the flood gates to investment, with or without policy changes.

"We disagree with the consensus view that elections can revive the investment cycle," Credit Suisse analysts said in a report published on March 20. "Only a fourth of projects are stuck with the central government, and two-thirds of these are in power and steel, both wracked with massive overcapacity."

Credit Suisse has outlined four scenarios in the India elections. The first is a Narendra Modi led government with 2-3 allies; the second is a Modi led government with 5-6 allies; the third is some other BJP or allied leader with 8-10 allies in parliament or a so-called "Third Front" government comprised of smaller parties that rival the BJP and Gandhi's Indian National Congress.

Modi aside, the real reason markets become so bullish on India is because of the RBI's new governor, 51 year old Raghuram Rajan.

In the first, base-case scenario, India's market rally is likely to continue providing the global economy remains in status quo, with no negative surprises in China, mounting tensions over Russia-Ukraine, or worsening U.S. and E.U. economies.

Credit Suisse said their base case will probably lead to another two to three months rally until investors come down from their Modi hangover and realize a democracy of this size moves very slowly.

The second case is relatively market neutral. It's the last two possible outcomes that will turn markets bearish.